Asset managers load up on aircraft-backed bonds
Oct 11 (IFR) - The bond markets are turning into a regular funding platform for airline companies which have in the past relied heavily on export credit agencies and commercial bank lending to finance deliveries of their vast aircraft fleets.
This week Virgin Australia capped an extraordinary year for aircraft-backed bonds with a successful deal that is expected to ensure the issuance momentum seen all through this year will carry on into 2014.
Fitch estimates about USD7bn of so-called enhanced equipment trust certificates (EETCs) backed by aircraft has been issued this year through September, and analysts say the year-end total may double last year's US$4.4bn tally.
Global EETC issuance has been roughly US$20bn since the asset class made a significant comeback in 2009. Issuance had dropped off precipitously following the onset of the financial crisis in 2007.
The rise in issuance follows increased demand from blue-chip investors like BlackRock and Pimco, and insurers such as New York Life, which have been rushing to buy paper from a sector that is broadly perceived to have an improved outlook and offers attractive yields relative to other similarly rated bonds.
Strong credit protections and legal frameworks also make these aircraft-finance bonds extremely attractive.
The bonds have so far come mostly in the form of EETCs, which are a hybrid of corporate bonds and securitized notes in that they are collateralized and bankruptcy-remote. The Virgin Australia deal was an enhanced equipment note (EEN), a type of EETC based on financed leases that does not use a special-purpose vehicle or trust.
The EETC structure is used heavily in the US, but has only recently made a comeback for non-US carriers, because some local insolvency laws do not have the same bankruptcy protections as the US.
Broadly speaking, both types of notes provide relatively predictable returns on an asset that is highly mobile, giving comfort to investors who may need to reclaim or repossess the asset in case of airline insolvency or default. The aircraft technically belong to investors, not the airline, until maturity.
In an EETC, "bond holders have security in a pool of underlying aircraft as well as some protection in the event of bankruptcy through special foreclosure privileges and liquidity facilities that cover bondholder interest payments over a period of time," wrote Mark Kiesel, Pimco's global head of the corporate bond portfolio management group.
The wide appeal for the paper was reflected in Virgin Australia's upsized US$797.22m EENs that were four times oversubscribed this week, with the largest interest coming from top US asset managers, according to sources familiar with the deal. The deal was increased from an original size of US$732.62m due to investor demand. Asian, European and Australian investors also participated.
The airline offered three tranches, with the top carrying an investment-grade rating and the other two rated high-yield. With a weighted average life of four years, the Class As paid a yield of 5%, while the other two tranches paid 6% and 7.125% respectively.
Virgin Australia's transaction was the first time that a non-US airline has used a EEN to refinance old aircraft after the planes have already been funded; typically this type of bond is used to pre-fund new aircraft that will be delivered within the following year.
VA also achieved the highest loan-to-value that any non-US airline has gotten on a EETC transaction to date.
"We enter this market with an expectation to come back to it," Sankar Narayan, the CFO of Virgin Australia, told IFR. "This was not a one-off event."
BLESSING IN DISGUISE
The opening of the bond funding option has come as a blessing for airlines, which are finding it harder to fund or refinance their aircraft via the traditional route of export credit agencies and commercial bank lending.
Beginning in January, higher fees and equity requirements mandated by the Organization for Economic Cooperation and Development (OECD) went into force, according to Boeing Capital Corp. Barring any severe shock, export credit support for new aircraft deliveries is expected to keep declining, Boeing wrote in a note to investors this year.
Moreover, commercial bank lending has become more expensive, leaving the capital markets as the most cost-effective option for funding.
"Record expected aircraft deliveries and tightened financing sources have created the need for increased capital markets activity," said Bradley Sohl, an asset-backed securities analyst at Fitch who rates bonds backed by cashflows from aircraft leases.
Both US and international EETC issuance is expected to spike within the next two years, and another less-utilized form of secured aircraft finance - securitizations of aircraft operating leases - is expected to make a comeback as well, after disappearing altogether for over five years.
Continued strong global air traffic and profitability over the last year have led to a stronger lessee base, Fitch's Sohl said, and values and lease rates have stabilized for aircraft, such as the A320, which showed particular weakness over the last few years following the bankruptcies of a few major operators.
GE Capital completed an innovative US$600m deal in the first quarter titled AABS Limited Asset Backed Secured Term Loan, linked to cashflows on 26 aircraft leases. The loans to AABS were backed by payments linked to operating leases and proceeds on a portfolio of 26 commercial aircraft manufactured by Airbus and Boeing.
In late August, an SPV subsidiary of Ireland-based Avolon Aerospace, an aircraft lessor owned by several investors including CVC Capital Partners and Oak Hill Capital Partners, priced US$636.21m in fixed-rate aircraft operating lease ABS. The issuer will use the proceeds to acquire a fleet of 20 aircraft.
The senior tranche received a rating of Single A from both S&P and Kroll, and yielded 4.75%. The Triple B rated tranche yielded 6.5%.
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